Your credit score is a crucial financial tool that can open doors to better interest rates, lower insurance premiums, and increased borrowing power.
One of the most effective ways to boost your credit score is by using a credit card responsibly. In this comprehensive guide, we’ll show you how to use a credit card to build credit while making the most of its benefits.
How do credit scores work?
Before we dive into the nitty-gritty of using a credit card to build credit, it’s essential to understand how credit scores work. Your credit score is a three-digit number that reflects your creditworthiness. It’s typically calculated using various factors, including your payment history, credit utilisation, length of credit history, types of credit accounts, and recent credit inquiries.
How to choose the right credit card?
Not all credit cards are created equal. Here’s what to consider:
- Secured credit cards: These require a security deposit, typically equal to the credit limit, which serves as collateral. A secured credit card can be a very good option for individuals with limited or poor credit histories, as it provides an opportunity to build or rebuild credit.
- Unsecured credit cards: Unsecured cards do not require a security deposit. They are available to individuals with better credit scores and histories. These cards often come with more favourable terms.
- Interest rates: Look for a card with a competitive APR (Annual Percentage Rate) to minimise interest charges if you carry a balance. The APR on credit cards is usually high.
- Fees: Pay attention to annual fees, late payment fees, and other charges associated with the card.
- Rewards: Some credit cards offer rewards like cashback, points, or miles. Choose a card that aligns with your spending habits and preferences.
- Introductory offers: Some cards may offer introductory 0% APR on purchases or balance transfers. These can be advantageous for saving on interest.
- Grace period: A longer grace period gives you more time to pay your balance without incurring interest charges.
Also read about: Credit cards for bad credit
How can a credit card help you to build credit?
When used responsibly, credit cards can significantly benefit your credit profile. Here’s how:
1. Establishing a credit history
For individuals who are new to the world of credit, a credit card provides an accessible way to start building a credit history. Credit history is a crucial component of your credit score, and without it, lenders have limited information to evaluate your creditworthiness. Using a credit card responsibly and making on-time payments can begin to establish a positive credit history.
2. Payment history
One of the most significant factors affecting your credit score is your payment history. Credit cards offer a consistent and easy way to demonstrate your ability to manage debt responsibly. When you make timely payments on your credit card balances, it reflects positively on your credit report and contributes to a higher credit score over time.
3. Length of credit history
The length of your credit history is another crucial factor in your credit score. Credit cards can help in this regard by allowing you to keep older accounts open. The longer you hold a credit card account in good standing, the more it contributes to the length of your credit history.
4. Diversification of credit types
Credit scoring models also consider the types of credit accounts you have. Having a mix of credit types, such as credit cards, instalment loans, and mortgages, can be viewed favourably by lenders. A credit card can add diversity to your credit profile, especially if you have other types of loans.
5. Building a positive credit history
Consistent, responsible use of a credit card over time builds a positive credit history that demonstrates to lenders that you are a reliable borrower. This can lead to better interest rates, higher credit limits, and more favourable terms when applying for other types of credit, such as auto loans, line of credit, or mortgages.
How to use a credit card to help you build credit?
1. Pay on time
Your payment history is a significant factor in your credit score. Always make at least the minimum payment and stay within your agreed credit limit.
2. Pay in full
Ideally, pay your statement balance in full each month to avoid interest charges.
3. Manage your credit utilisation
Keep your credit utilisation ratio (credit card balance vs. credit limit) below 30%. High utilisation can negatively impact your credit score.
4. Don’t max out your card
Avoid maxing out your available credit as it can indicate financial instability to creditors.
5. Monitor your statements
Regularly review your credit card statements for errors or unauthorised charges.
Can I build credit if I become an authorised user on a credit card?
Yes, becoming an authorised user on a credit card can help you build credit. However, the impact on your credit profile may vary depending on how the account is managed.
Things to keep in mind:
- Communication with the primary cardholder is crucial. Ensure that you’re both on the same page regarding how the credit card will be used and how payments will be made.
- Understand that you are not legally responsible for the debt. However, any unpaid balances or late payments on the card can potentially affect your credit since it’s linked to your credit report.
- It’s a good idea to monitor your credit reports regularly to ensure that the account is being reported accurately.
- While being an authorised user can help build credit, it may not have as significant an impact as having your individual credit accounts, such as a credit card or a loan, in your name.
How do credit builder cards work?
Collateral deposit: When you open a secured credit card account with the intention of building credit, you’ll be required to make a security deposit, which serves as collateral.
Monthly payments: Instead of using the card for purchases, you make monthly payments, which are applied towards repaying the collateral deposit. Essentially, this creates a “loan” that you are repaying over time.
Building credit: As you consistently make on-time payments you’re establishing a positive payment history.
However, it’s also important to keep in mind the interest and fees. Some secured credit cards may charge interest or fees on the collateral deposit or for the privilege of using the card in this manner. Be sure to review the terms and conditions carefully.
Advanced credit card strategies
Here are advanced credit card strategies to help you optimise your credit:
1. Credit limit increases
Regularly requesting credit limit increases can be beneficial for your credit utilisation ratio. When your credit limit increases and you maintain your current balance, your utilisation ratio decreases. To increase your chances of approval, demonstrate responsible credit card usage by making on-time payments and managing your credit responsibly.
2. Responsible use of multiple cards
Managing multiple credit cards can be advantageous when done responsibly. It allows you to diversify your credit profile by showing that you can handle different types of credit. However, it’s essential to keep your balances low and make on-time payments on all your cards. Avoid opening too many new accounts in a short period, as this can negatively affect your credit score.
3. Maintaining a long credit history
The length of your credit history plays a crucial role in your credit score. Keeping older credit card accounts open can positively impact your credit score by increasing the average age of your accounts. Be cautious about closing old accounts, as this can potentially lower your credit score. If an older card has no annual fee, it’s often best to keep it open.
4. Prepaid credit card to build credit
Prepaid credit cards, while not traditional credit cards, can be a useful tool for building credit. These cards require you to deposit funds upfront, and your spending is limited to the amount you’ve deposited. The key advantage is that some prepaid card issuers report your payment history to credit bureaus. This means your responsible use can contribute to establishing a credit history.
Conclusion
In conclusion, having active credit accounts can help you build credit. Key takeaways include making consistent, on-time payments, optimising credit utilisation ratios, and avoiding maxing out credit limits. You can observe the impact on your credit report by checking your credit score on a regular basis.
Take proactive steps towards leveraging your credit card for credit building by selecting the right card for your needs, setting up automatic payments, and integrating it into your budget.
Frequently Asked Questions
How much does a credit score decrease when it is checked in the UK?
Checking your own credit score doesn’t affect it because it’s just a soft inquiry. Your credit score will only be affected when a lender or credit card company pulls it.
What makes your credit score go down in the UK?
Your credit score in the UK can decrease due to missed or late payments on credit accounts, high credit card balances compared to your limit, defaults on loans or accounts in collections, and frequent credit applications within a short period.
Is 600 a good credit score in the UK?
According to Experian, a credit score ranging close to 600 is not ideal. You need to score at least 721 on the scale to make it to a ‘fair’ range.
What is an excellent credit score in the UK?
A credit score between 961-999 is considered excellent according to Experian.
Disclaimer: The information given above is provided for reference only. This is not financial advice.
Related guides:
How To Use a Line of Credit Responsibly
